08ASTANA91, KAZAKHSTAN: ALL SIDES SMILING WITH KASHAGAN DEAL

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C O N F I D E N T I A L ASTANA 000091
SIPDIS
SIPDIS
E.O. 12958: DECL: 01/18/2018
TAGS: EPETEINVECONKZ
SUBJECT: KAZAKHSTAN: ALL SIDES SMILING WITH KASHAGAN DEAL
Classified By: Ambassador John Ordway, Reasons 1.4 (b) and (d)
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SUMMARY
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¶1. (C) In a marathon negotiating session on January 13, the
Kashagan consortium partners reached agreement in principle
with the Government of Kazakhstan (GOK) on restructuring the
ownership and operatorship of the project, overcoming two
main stumbling blocks. ENI had objected to a new operating
model; ExxonMobil had rejected the price for the equity stake
transferred to KazMunayGaz (KMG), Kazakstan's national oil
and gas company. With the CEOs of all six foreign partners
and Kazakhstani Prime Minister Masimov in the same room, ENI
and ExxonMobil found themselves isolated and eventually
joined the consensus. The parties agreed to an equity
transfer to KMG that will result in KMG -- and thus the GOK
-- having a Kashagan ownership share equal to that of the
four largest consortium partners. They also agreed to a new
operating model which will bring ExxonMobil, Shell and Total
in as co-operators, each with a specific area of
responsibility. KMG will share in overall management, and
intends to ensure smooth and effective relations among the
operating companies. End Summary.
¶2. (C) This cable is based on separate, extensive
conversations after the agreement was reached with senior
in-country management for ExxonMobil and ConocoPhillips, and
with Maksat Idenov, KMG's first vice president.
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OPERATORSHIP
------------
¶3. (C) ENI has been the operator during the initial phase of
Kashagan -- the world's largest oil discovery since Alaska's
North Slope. By all accounts from companies within and
outside the consortium, ENI does not have the capacity to
operate a project of this complexity, which will entail
extraction of sour oil under extremely high pressures using a
complex and potentially dangerous gas reinjection scheme.
The result has been repeated delays and massive cost
overruns. The consortium partners we have been in regular
contact with (ExxonMobil, ConocoPhillips and Shell) have been
telling us privately since at least 2004 that ENI was in over
its head. All the parties except ENI had long come to the
conclusion that a new operating model was required.
¶4. (C) All of our interlocutors described ENI as being in
denial until the very last moment of the negotiations about
their inability to continue as Kashagan operator. KMG First
Vice President Maksat Idenov told us that he had worked with
ExxonMobil, ConocoPhillips and Shell to devise an approach
that would have the GOK, rather than the international
companies, demand a change in the consortium's operating
structure. In the course of the final nine-hour negotiating
session, ENI CEO Paolo Scaroni, completely isolated and under
attack particularly from ExxonMobil and Shell, finally gave
in. The new arrangements, which will be worked out among the
four majors involved within the next 4-6 weeks, envision
dividing the operatorship into different aspects, including
offshore, onshore, and drilling. The companies will reach
the decision on who does what based on capabilities and
availability of the appropriate expertise.
---------------------
COMPENSATION/FINANCES
---------------------
¶5. (C) In addition to the value transfer as a result of KMG's
acquiring additional equity (para 6), the January 13 Kashagan
deal also includes cash compensation to KMG. The most
significant component is a $250,000,000 bonus payment to be
made upon the commencement of production. ExxonMobil had
tried to mitigate the value transfer by seeking a 10 year
extension of the PSA, later reducing their demand to 5 years
and then 3 years. The GOK stood firm, but did agree to give
the current partners a right of first refusal on any
extension or new PSA at its expiry. (Note: The size of the
field and the delays in beginning production make it very
likely that there will be substantial oil still in the ground
when the current PSA expires. Given the reinjection of sour
gas and high pressure in the fields, it is likely that even
at that point the project will continue to be technically
demanding and require the involvement of international
majors. End Note.)
¶6. (C) Our intelocutors report that at no point during the
negotiations did the GOK request the international partners
to assume any responsibility for financing KMG's very large
cash calls for capital expenditures and operating expenses
over the next several years. Idenov told us that KMG plans
to finance part of these cash calls through its own
resources, and part by debt financing. He is planning a
series of meetings with selected major European and Japanese
banks over the next month or so to begin to line up
commitments.
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OWNERSHIP
---------
¶7. (C) The GOK had signaled early on that it was seeking &#x00
0A;additional equity ownership to bring KMG's share in Kashagan
up to the same level as the four large stakeholders -- ENI,
Shell, Total and ExxonMobil -- and that it expected part of
the compensation it felt it was due for delays and cost
overruns to be reflected in the purchase price for KMG's
additional stake. In the initial stages of the negotiation,
it appeared that the GOK was preparing an all-out assault to
get the consortium partners to agree to dilution of their
shares. The GOK's arsenal included environmental charges,
tax charges, labor violations, operating permits, the
requirement for GOK approval of the operating budget and,
most ominously, a new subsoil law that provided a potential
legal basis to revoke the PSA. As serious negotiations got
underway, however, all of these threats receded. (Note: The
one exception was a threat by President Nazarbayev in a
December meeting with Tillerson's deputy to use the subsoil
legislation. Nazarbayev, however, reverted to his previous
public line when he reassured the Ambassador privately the
next day that the legislation would not/not be used against
any existing contract. End Note.) In the end, both
ExxonMobil and ConocoPhilips confirmed that the GOK used
tough, but legitimate business pressures to pursue their case.
¶8. (C) ExxonMobil was the last holdout in agreeing to an
increased ownership share for KMG. After Exxon signaled its
willingness late last year to reduce its stake, the
negotiations focused on the price for KMG's share.
ExxonMobil, however, took a position of principle: it would
accept no less than "market price." ExxonMobil told us that
CEO Rex Tillerson had decided that Exxon was going to hold
the line on this issue. However, all our sources indidated
that Tillerson was subjected to very strong pressure in the
final negotiations, both by the other CEOs and by the
Kazakhstani side. According to our in-country ExxonMobil
contact (who was not in the meetings but who was extensively
debriefed about them), it was the lure of future business in
Kazakhstan that eventually led Tillerson to reverse course,
and to agree to a "below market price" figure of $1.8 billion
as the valuation of KMG's increased share. (Note:
Determining the "market price" for this share is essentially
impossible, as different financial models will yield wildly
varying results depending on the assumptions used. That
said, all parties involved agree that $1.8 billion is a
"below market price," even if they can not tell you how much
below market. End Note.)
¶9. (C) ExxonMobil has been pursuing a major and innovative
on-shore proposal with the GOK for the past 18 months that
would build on the company's acknowledged industry-leading
skills and, if successful, produce major additional revenues
for Kazakhstan. It was made explicit to ExxonMobil that
failure to agree to the restructuring proposal would result
in their losing any chance of additional business in
Kazakhstan -- permanently. It apparently was the lure of
this opportunity that persuaded ExxonMobil to accept what all
the other majors had already agreed to. ExxonMobil told us
that no promises were made about any future business, and the
GOK is on the record publicly as saying that there were no
side deals made. However, Idenov strongly hinted to us that
an agreement with ExxonMobil was imminent -- and went out of
his way to praise Exxon's professionalism, high standards,
and critical role in the new operatorship arrangements for
Kashagan. He claimed he had told Tillerson that ExxonMobil
could have first pick on the aspect of the operatorship they
wanted. The ExxonMobil office in Astana is scouring the town
for new office space, and is anticipating the imminent
arrival of more business development cadres.
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COMMENT
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¶10. (C) While KMG will benefit from some relatively modest
guaranteed cash transfers, the real financial gain from the
Kashagan deal for Kazakhstan is a greater share of upside
potential if oil prices remain high -- though coupled with
greater downside risk if prices drop or production does not
materialize as projected. ExxonMobil evidently decided that
the risk of being permanently shut out of development
prospects in Kazakhstan was not worth the further argument on
the market value of its existing Kashagan stake. For its
part, ConocoPhillips is also bullish on its prospects in
Kazakhstan over the next few years. They have offered to
second technical experts to KMG, at no cost, to help them
evaluate the N Block that Shell and ConocoPhillips had fought
so hard over, and that KMG is now going to explore on its
own. Idenov apparently has high regard for ConocoPhilips CEO
Jim Mulva -- a fact that may further work to the benefit of
the company. End Comment.
ORDWAY

The information recorded on this site has been extracted from http://Wikileaks.org (Kazakhstan) database..

We wish to express our gratitude to Julian Assange and his team for making this data available as it is an important public record.

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